Video Game Stocks: Sector Analysis for Investors

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

This newsletter lists the key events (including key game releases and financial news) in September, previews our expectations for October, and provides our views of the current state of the video game industry.

The Wedbush Video Game Index—our market cap-weighted index of video game companies—performed slightly better than the broader market averages, with a September increase of 4% due to a strong month for Nintendo (TYO:7974), which was up 14%. The Russell 2000 and S&P 500 increased 3% and 2%, respectively, due to QE3 and vacillating concerns around the E.U. On September 13, Nintendo provided additional detail about the Wii U, including pricing, release dates, and a stronger-than-expected launch release slate. We expect strong initial demand for the console due in large part to a dedicated fan base, and expect Nintendo shares to trade higher. GameStop (NYSE:GME) also benefited from Wii U chatter, increasingly positive sentiment on the sell-side, and several high-profile releases. Majesco and THQ (NASDAQ:THQI) had the worst monthly performance, down 26% and 23% due to weak quarterly results combined with a worse outlook and liquidity concerns, respectively. On a constant f/x basis, the index increased 4%. The index decreased 3% excluding Nintendo (on a constant f/x basis, as well).

August U.S. console software sales were $238 million, down 9% from last year’s $262 million, and roughly in line with our $240 million estimate. Units were down 14%, with ASPs up 5%. PC software sales were $15 million, down 30%. Software sales for the HD consoles and handhelds were roughly flat, with the Wii accounting for almost the entire decline. Hardware sales were $151 million, down 39% compared with last year’s $248 million, and below our estimate of $161 million—so combined hardware and software (including PC) sales for August were down 24% y-o-y.

We expect September console software sales to be led by new releases Electronic Arts (NASDAQ:EA)’ FIFA Soccer 13 (360, PS3, Wii, PC, PS2, PS Vita, 3DS, PSP) and Madden NFL 13 (360, PS3, PS Vita, Wii), and Take-Two (NASDAQ:TTWO)’s Borderlands 2 (360, PS3, PC). We believe many of the publishers remain undervalued. In our view, it is unlikely that gamers are abandoning their passion in favor of other forms of entertainment, and inconceivable that if packaged goods sales have declined, people formerly playing games are now doing something unrelated. We think that the market has this one wrong, and we believe that historically low valuations for the publishers present an opportunity for investors to generate positive returns.

Key September headlines:

o 9/6 – NPD U.S. console software sales were roughly in line with our expectations, while hardware sales were below.

o 9/10 – Majesco reported worse-than-expected Q3 results, and disclosed that FY:12 results were expected to be in the

lower end of the guidance range.

o 9/13 – Nintendo announced the pricing and release dates for the Wii U at the Wii U Preview event in New York City.